Destabilizing Stability? Exchange Rate Arrangements and Foreign Currency Debt

August 28, 2020

Preview Citation

Format: Chicago

Balazs Csonto, and Tryggvi Gudmundsson. Destabilizing Stability? Exchange Rate Arrangements and Foreign Currency Debt, (USA: International Monetary Fund, 2020) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

Emerging markets (EMs) often respond to shocks by intervening in foreign exchange (FX) markets and thus preventing full exchange rate adjustment. This response can serve to dampen the effect of shocks and increase monetary policy space but may also incentivize economic participants to increase risk taking and take on more FX debt. This paper empirically analyzes the role of exchange rate flexibility in affecting such risk taking, by using rolling correlations and difference-in-difference estimations. The results suggest that a shift towards greater exchange rate flexibility often coincides with a decline in external FX debt. The findings also highlight the importance of using complementary policies to deal with financial stability issues related to the exchange rate, such as FX-specific macroprudential policies and policies aimed at promoting financial development.

Subject: Exchange rate arrangements, Exchange rate flexibility, Exchange rates, External debt, Foreign exchange

Keywords: Asia and Pacific, Carry trade, Central and Eastern Europe, Debt, Equilibrium exchange rate, Europe, Exchange Rate, Exchange rate arrangements, Exchange rate flexibility, Exchange rate flexibility, Exchange rate volatility, Exchange rates, External Debt, FX debt, FX debt of a company, FX Intervention, FX purchase, FX stability, Global, Heightened exchange rate volatility, Middle East, Monetary Policy, Movements in the presence, North Africa, Regime shift, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/173
Stock No:

WPIEA2020173
ISBN:

9781513555928
ISSN:

1018-5941

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